The Risks of Climate Change are Already Material: New Ceres/EDF Study Calls for SEC to Mandate Better Disclosure

As the Obama Administration seeks to overhaul financial regulation, a multi-trillion-dollar coalition of investors has argued that the government should require corporate disclosure of climate change-related risks. Climate Risk Disclosure in SEC Filings – a deceptively modest title – calls for replacing the current hodgepodge of voluntary disclosure with a federally mandated reporting regime.

Perhaps the most provocative assertion in Climate Risk Disclosure is that voluntary disclosure, much like the "self-policing" practices that have supplanted direct regulation in many industries, is inadequate to its task.

"Climate change is for many companies a material risk," the authors write. They argue that the SEC, in its role as guarantor of the transparency of American securities markets, is already obligated to demand broad, uniform reporting of corporate climate-related risk exposure.

Indirect regulatory risks and opportunities related to products or services from high emitting companies

Litigation risks for emitters of greenhouse gases

Broad Exposure, Limited Disclosure

Most companies, even those from the sectors that emit the most GHG, do not do enough to inform shareholders of how climate change threatens their business models. The report's authors reviewed climate risk disclosure in SEC filings from Q1 2008:

"[The study] evaluates the current state of climate risk disclosure by 100 global companies in five sectors that have a strong stake in preparing for a low carbon future: electric utilities, coal, oil and gas, transportation and insurance….
"Fifty-nine companies made no mention of their greenhouse gas emissions or their position on climate change, 28 had no discussion of climate risks they face, and 52 failed to disclose actions to address climate change. Even more telling, the very best of disclosure for any of the companies could only be described as 'Fair'–and only a handful of companies achieved this ranking."

It is significant that Climate Risk Disclosure looks at the insurance sector, along with industrial sectors that directly produce and consume large quantities of fossil fuels. Assessing, pricing and managing risk is what insurers do, yet US firms made little mention of their exposure to their customers' climate change risks:

"Eighteen out of 27 [researched insurance] companies (67%) had no mention of climate change or related risks anywhere in their SEC filings. Twenty-three out of 27 companies (85%) failed to disclose their emissions or a statement on climate change, while 24 out of 27 companies (89%) omitted disclosure on actions to address climate change, despite the wide range of opportunities for new, climate-related insurance products."

Why are US firms lagging? The Ceres/EDF study suggests a simple answer: European companies face climate change in a more demanding regulatory climate.

What does Voluntary Disclosure Hide?

Climate Risk Disclosure provides a useful summary of why voluntary disclosure, like other forms of "self-regulation," tends to fall short of its promises:

"First, because it is voluntary, companies without a positive story to tell can simply decide not to disclose. In this way, disclosure will be skewed toward companies that are better positioned to address the risks and opportunities presented by climate change. …
"Second, voluntary disclosure tends to focus on opportunities related to climate change while omitting or downplaying the risks. [A] 2007 KPMG/GRI study found that in sustainability reports, 'companies reported far more on potential opportunities than financial risks for their companies from climate change.'…
"Third, voluntary disclosure is not uniform, frustrating efforts to benchmark companies against one another. …
"Fourth, companies making voluntary disclosure tend not to quantify the financial impact of risks and opportunities. …
"Finally, voluntary disclosure lacks the enforcement mechanism that comes with mandatory disclosure requirements."

Largest Investors Must Prepare for the Broadest Risks

In a preface to Climate Risk Disclosure, Anne Stausball of the California Public Employees' Retirement System (CalPERS) writes:

"CalPERS has a widely diversified portfolio that is impacted by all segments of the economy. The fund also has a long-term perspective, since it must meet beneficiaries' retirement needs now, and long into the future. As such, we must be aware of shifting conditions and liabilities affecting companies in our portfolio."

CalPERS is a leading member of the Ceres-led Investor Network on Climate Risk (INCR), a coalition of investors managing around $7 trillion of assets. Ms. Stausball notes that in 2007, CalPERS and the INCR petitioned the SEC "to ensure that publicly traded companies disclose material financial risks from global warming in securities filings, as required under existing securities law." [Emphasis added.]

The new Ceres/EDF research supports this contention: the SEC is already obligated, by the terms of existing rules, to require mandatory disclosure.

Item 303 and the Materiality of Climate Risk

Climate Risk Disclosure explores the various regulations that define what all publicly-traded companies must tell their shareholders, including "Item 303." The report says that the obligations of this rule, according to SEC statements, "encompass both financial and non-financial factors that may influence the business, either directly or indirectly." In summing up the implications of Item 303, the authors issue an unequivocal challenge to the SEC:

"The risks and opportunities created by climate change clearly fit within the range of factors to which Item 303 applies. The scientific consensus and improved ability for scientists to quantify likely climate change impacts preclude an argument that climate change is not a 'known' trend or uncertainty. The rapidly changing [environmental] regulatory environment introduces the possibility that past financial results will not be indicative of future results, and the effect is certainly material for many companies."